10-18 WACC and optimal capital budget Adams corporation is considering four aver

Question

10-18 WACC and optimal capital budget Adams corporation is considering four average risk projectswith the following costs and rates of return: project cost expected return 1 2,000 16% 2 3,000 15% 3 5,000 13.75% 4 2,000 12.50%
The company estimates that it can issue debt at a rate ofrd =10%,and its tax rate is 30%. It can issue preferredstock that pays a constant dividend of $5 per year at $49 pershare. Also its common stock currently sells for $36 per share,thenext expected dividend D1 , is $3.50,and the dividend isexpected to growat a constant rate of 6% per year. The targetcapital structure consits of 75% common stock,15% debt,and 10%preferred stock. a. what is the cost of each of the cpaital componets? b. what is Adams WACC? c. Which projects should Adams accept? 10-18 WACC and optimal capital budget Adams corporation is considering four average risk projectswith the following costs and rates of return: project cost expected return 1 2,000 16% 2 3,000 15% 3 5,000 13.75% 4 2,000 12.50% project cost expected return 1 2,000 16% 2 3,000 15% 3 5,000 13.75% 4 2,000 12.50%
The company estimates that it can issue debt at a rate ofrd =10%,and its tax rate is 30%. It can issue preferredstock that pays a constant dividend of $5 per year at $49 pershare. Also its common stock currently sells for $36 per share,thenext expected dividend D1 , is $3.50,and the dividend isexpected to growat a constant rate of 6% per year. The targetcapital structure consits of 75% common stock,15% debt,and 10%preferred stock. a. what is the cost of each of the cpaital componets? b. what is Adams WACC? c. Which projects should Adams accept? project cost expected return 1 2,000 16% 2 3,000 15% 3 5,000 13.75% 4 2,000 12.50%

Explanation / Answer

Preferred Stock: K= 5/49 times 0 growth = 10% [ (Dividend/price) +growth Debt: K= (YTM) * (1-T) = 10% times 1-.3 = 10% times .7 = 7% Common stock = K = 3.5/36 + 6% = 10% + 6% = 16% [(dividend/price) +growth] Cap structure Cost of cap weighted ave Debt 15% 7% 1.05 Common stock 75% 16% 12.00 Preferred stock 10% 10% ___1.00___ 14.05% = WACC Which investments? Project 1 & 2 are greater than 14.05%

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